The UK’s financial regulator is looking at ways to improve liquidity management in the country’s £11tn asset management industry as part of a post-Brexit review of how it regulates the sector following a blow-up in the pensions market last year.
On Monday the Financial Conduct Authority announced a consultation on how it could improve its current regime for regulating the UK’s 2,600 asset management firms. The regulator said it was seeking to boost competition, encourage innovation and protect investors.
The FCA said that future rules around liquidity management — which determine how funds ensure they can meet investor requests to withdraw their money — must be looked at in the context of “the good functioning of markets” as well as “protecting consumers” in light of the “growth of the funds industry”.
A sell-off in the gilts markets last autumn exposed liquidity and operational weaknesses in the market for liability-driven investing, a popular strategy among the UK’s “defined benefit” pension funds to help manage their funding risks. The crisis threatened to destabilise the wider financial system.
A spike in bond yields in the aftermath of then chancellor Kwasi Kwarteng’s “mini” Budget triggered collateral calls on thousands of pension funds that used hedging contracts, forcing the plans to rapidly sell assets including gilts to replenish collateral.
The liquidity crisis spilled over into other parts of the market, including real estate, prompting several asset managers to restrict withdrawals from property funds because they were unable to handle heavy demand from investors.
The crisis came as the UK prepared to redraw its financial regulation rule book in the aftermath of Brexit. The FCA, and the Prudential Regulation Authority, which regulates Britain’s biggest banks and insurers, must transpose thousands of pages of EU law into new UK legislation.
The UK government and regulators have promised that the new approach will be more flexible to changing industry dynamics, and more appropriate for the British market, and insist that the reforms will not lead to a wave of deregulation that could sow the seeds for future crises.
As they undertake the mammoth job, UK regulators have grown increasingly concerned about the broader market fragilities that were highlighted in recent blow ups such as September’s pension fund meltdown.
The Bank of England’s Financial Policy Committee, which is responsible for identifying risks building in the financial system, has repeatedly cited “challenging liquidity conditions” as a potential flashpoint, prompting the central bank to launch what it says is the world’s first stress test of market liquidity.
Meanwhile, the PRA is pushing banks to more carefully scrutinise the threats their asset management clients are exposed to, including liquidity risks.
The UK’s actions come amid a broader global push to tame risks that have migrated from the now heavily regulated banking sector into other parts of the financial system, including hedge funds and asset managers.
The FCA said on Monday that it is looking for areas where rules might be “limiting the potential for innovation or efficient use of modern technology”. It highlighted the transformational potential of fund tokenisation, in which investors are issued with digital tokens instead of traditional shares or fund units.
Leonard Ng, a partner at law firm Sidley Austin in London, welcomed the FCA consultation but said “the UK should be sensitive to the likely high costs and disruption that would result from a major overhaul of its asset management regulatory framework”.
The deadline for submissions in response to the discussion paper is May 22.
